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The Impact of the PricewaterhouseCoopers Merger on Auditor-Client

Alignment

Article in Pacific Accounting Review · March 2006

DOI: 10.1108/01140580610732778

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 The Impact of the PricewaterhouseCoopers

Merger on Auditor-Client Alignment

Sumithira Thavapalan1

Robyn Moroney2

Roger Simnett3

Final version published as: S. Thavapalan, R. Moroney and R. Simnett, “The Impact
of the PricewaterhouseCoopers Merger on Auditor-Client Alignment”, Pacific
Accounting Review 18(1) 2006, 70-89.

2006

1 University of New South Wales, Sydney, 2052, Australia.

2 Senior Lecturer, Department of Accounting and Finance, Monash University, Box 197 Caulfield East, Vic.
3145 Australia
3 Professor, School of Accounting, University of New South Wales, Sydney, 2052, Australia.

Please send any correspondence to Robyn Moroney, Department of Accounting and Finance, Monash
University, Box 197 Caulfield East, Vic. 3145 Australia. Phone: (613) 9903 2383. Fax: (613) 9903 2422. Email:
robyn.moroney@buseco.monash.edu.au
 The Impact of the PricewaterhouseCoopers

Merger on Auditor-Client Alignment

Abstract

This paper investigates the impact of the PricewaterhouseCoopers (PwC) merger in

Australia on existing and potential clients of the new merged firm. From prior theory

it is expected that some existing clients may have an incentive to switch away from a

newly merged firm as the same larger firm now audits close competitors once audited

by separate firms. Prior theory also suggests that another group of potential clients

should be attracted to the newly merged firm where the merger enhances or creates

industry specializations. The expectation is that in both of these instances there will

be increased switching activity associated with the newly merged audit firm. Contrary

to expectations, a significantly lower level of switching behaviour was observed for

the newly merged firm compared with that of the other Big 5 firms, suggesting that an

advantage of enhanced specialization may not be the attraction of new clients but the

retention of existing clients. When comparing the nature of the switches, some

support was found for the view that the switches to the new firm were likely to be in

enhanced areas of specialization, but no evidence was found to suggest that close

competitors would switch away from this firm. The greater rate of retention of clients

compared with other Big 5 firms was not associated with a more competitive audit

pricing policy.

Key Words: Auditor-client alignment, industry specialization, client concentration.

1
 (1) INTRODUCTION

Coopers and Lybrand (CL) and Price Waterhouse (PW), two of the then Big Six audit

firms, announced on 18 September 1997 their intention to merge their international

practices from July 1998, to form PricewaterhouseCoopers (PwC).1 The merger

provides an opportunity to explore the effect of industry specialization and client

concentration on auditor-client alignment. Prior to the merger, clients would have

been aligned with the audit firm perceived as most suited to their needs. However, the

merger may have created incentives for both potential and existing clients to

reconsider their choice of auditor. Some potential clients may have switched to the

newly merged firm because of its newly developed or enhanced expertise in specific

industries, and some existing clients in concentrated industries may have switched

away from the newly merged firm because it now also audits their direct

competitor(s). Both of these arguments suggest that there is an additional incentive to

switch for both existing and potential clients of the newly merged audit firm.

With regards to enhanced industry specialization the merger brought together the

knowledge, skills and expertise of two Big 6 audit firms. The international Chairman

of PwC asserted that “unlike previous mergers2 in our business, our decision to

combine has been driven by the recognition that clients require seamless global

support and unprecedented levels of expertise that, until now, were simply not

available from any one organization” (PwC press release, 18 September 1997,

emphasis added). Thus, it was anticipated that enhanced industry specific expertise of

the combined firm might attract new clients.

2
A major contribution of this paper is to provide evidence on the extent to which

potential clients are attracted to industry specializations that are newly created or

enhanced as a result of the merger. While audit firms have specialized in industries to

attract particular clients (see e.g., Solomon et al., 1999), there is currently little

empirical evidence on the effect of industry specialization on auditor switching

behaviour. Thus we are unsure when we observe industry specializations whether they

do serve to attract potential clients. This paper therefore has the ability to add to our

understanding of auditor-client alignment associated with industry specialization.

The merging of two audit firms can also result in the newly merged firm auditing

clients that are in direct competition. This was suggested as a major issue when

KPMG and Ernst and Young considered merging (Hogan and Jeter, 1999). It was

suggested that these firms might have deferred merging in case they lost clients such

as Coca Cola and Pepsi, audited by Ernst and Young and KPMG respectively (ibid).

Kwon (1996) posited that clients in concentrated industries are reluctant to use the

same audit firm because of concerns that confidential information may be transferred

to competitors.

The second major contribution of this paper is that it tests Kwon’s (1996) theory by

examining the reaction of clients in concentrated industries to the merger between

their audit firm and the firm auditing their existing industry competitors. As a result of

the merger, clients in concentrated industries were confronted with a situation in

which Kwon (1996) suggested they might demand different audit firms to that of their

close competitors. This theory indicates that switches away from PwC by clients in

concentrated industries may be expected. This study examines whether there is

3
increased switching behaviour involving PwC associated with client industry

concentration, as well as examining switching behaviour associated with large close

competitors that, as a result of the merger, would be audited by the same audit firm.

The paper is structured as follows. The next section contains a review of the literature

and development of the hypotheses. The methodology is discussed in section 3. The

results are presented in section 4 and the discussion of results in section 5 concludes

the paper.

(2) LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT

2.1 Comparing the number of switches involving PwC

It is anticipated that there are incentives for potential clients to switch to PwC as a

result of the newly created or improved areas of industry specialization. Research has

associated industry specialization with both improved audit quality and efficiencies

due to economies of scale (e.g. Carcello et al., 1992; DeFond, 1992; Beattie and

Fearnley, 1995; Craswell et al., 1995; Behn et al., 1997; Solomon et al., 1999,

Ferguson and Stokes, 2002; Ferguson et al., 2003). DeAngelo (1981) defines audit

quality as the probability that an auditor both (1) discovers a breach in the accounting

system and (2) reports that breach. Studies have shown that industry specific

knowledge enhances an auditor’s ability to discover breaches. For example, O’Keefe

et al., (1994) find that industry specialization is associated with fewer violations of

GAAS reporting standards. In addition, industry specialist audit firms provide greater

assurance that breaches are reported because they have a disproportionate amount of

reputation at stake in the industry (DeFond, 1992).

4
A few studies have investigated the impact of specialization on auditor switching.

Both Williams (1988) and Haskins and Williams (1990) find that clients tend to

switch to industry specialist audit firms within the then Big 8. On the other hand, as

outlined earlier, Kwon’s (1996) findings suggest that clients in concentrated industries

may switch away from an audit firm that is associated with a close competitor.

From the above discussion, there is an increased incentive for certain potential and

existing clients to switch to or from PwC following the merger. Ceteris paribus, this

should result in an auditor-client switching rate above that observed for the other Big

5 firms. This leads to the following hypothesis:

H1. The proportion of switches involving the newly merged audit firm of PwC
is greater than the proportion of switches involving other audit firms of similar
size.

2.2 Examining client switches to PwC

Industry specialization impacts perceived audit quality. This means that third parties

use this expertise as a way of gauging audit quality from a distance (for example,

Eichenseher and Shields, 1983; Shockley and Holt, 1983; Carcello et al., 1992;

Beattie and Fearnley, 1995; Behn et al., 1997; Hogan and Jeter, 1999; Ferguson and

Stokes, 2002). Potential clients may have been attracted to the merged audit firm,

because PW and CL claimed to possess complementary strengths, which allowed the

newly merged firm to provide a greater breadth of industry expertise. For example,

CL’s worldwide expertise in telecommunications was claimed to complement PW’s

strength in media and entertainment. PW also claimed to have expertise in chemicals,

CL in consumer products and manufacturing, while there were complementary

strengths in oil and gas (PwC Press Release, 18 September, 1997). The merger was

5
also observed as resulting in more refined categories of specialization in Australia.

Pre-merger, CL in Australia was divided into only two industry groups, namely,

industry and commerce, and financial services. Post-merger, PwC’s audit services

division comprised five main industry groups; (i) consumer and industrial products,

(ii) services, (iii) technology information communications and entertainment, (iv)

energy and mining, and (v) financial services. PwC therefore appeared to be more

specialized and better able to offer a greater breadth and depth of expertise. In

addition, PwC promoted the merger as having developed “unprecedented levels of

expertise”. Consequently, potential clients in the industries that the newly formed

PwC specialized in were expected to perceive that PwC was able to provide a higher

quality audit and therefore have increased incentive to switch to the merged firm.

On the basis of the prior discussion it is expected that post-merger switches to PwC

are more likely to occur in those industries where industry specialization was created

or enhanced as a result of the merger. This is tested by the following hypothesis.

H2. Of the clients switching to PwC, there is a higher proportion in industries

where specializations are newly created or enhanced.

2.3 Examining client switches from PwC

Kwon (1996) posits that clients in more concentrated industries tend to align with

audit firms not associated with their competitors because they do not want to risk the

transfer of proprietary information. He uses a four firm client concentration ratio,

which measures the percentage market share of the four largest companies in an

industry, to proxy the degree of client concentration. The results show that it is less

likely for an audit firm to dominate in concentrated industries. Hogan and Jeter (1999)

6
find mixed support for Kwon’s (1996) conjecture, with their results sensitive to the

specification of the measure for dominance. While their results are consistent with

those of Kwon (1996) for Kwon’s measure of dominance, they obtain opposite results

when dominance is measured using the percentage of an industry audited by the top

three auditors.

From the above discussion of Kwon (1996) it is expected that post-merger switches

away from PwC are more likely to occur in industries of higher client concentration.

This is tested by the following hypothesis.

H3. Of the clients switching away from PwC, there is a higher proportion in
industries of high client concentration.

(3) METHODOLOGY

3.1 Auditor Switches

CL and PW first announced plans to merge their practices in September 1997 (PwC

press release, 18 September, 1997). Therefore, switches to and away from PwC

between September 18, 1997 and September 1999 are examined. A two year window

from the time of the announcement of the merger is deemed to be an appropriate time

frame given the motives for change of auditor examined in this paper. 3 To identify the

switches, we compare a listing of PW and CL clients in 1997 with a listing of PwC

clients in 1999.

Huntley’s datadisc, which covers all listed Australian companies, is used to identify

clients of PW and CL listed on the Australian Stock Exchange in 1997 and listed PwC

clients in 1999. Companies reported on Huntley’s datadisc as having PwC as auditors

7
in 1999 but not in 1997 are clients that potentially switched to PwC. Conversely,

companies that are reported in Huntley’s datadisc in 1997 as being clients of either

PW or CL but are not reported as clients of PwC in 1999 are clients that potentially

switched to another auditor.4 Of the potential switches identified, those that occurred

after September 18, 1997 were isolated by looking through Australian Stock

Exchange (ASX) announcements reported in Huntley’s datadisc, and annual reports

contained on the Connect 4 and ASX Annual Reports databases.5

3.2 Proxies for Industry Specialization

It is first necessary to develop appropriate measures for identifying an industry

specialist in order to examine switches due to industry specialization. Prior research

has used disparate proxies for industry specialization. However, the reasons for

employing these proxies are not always well established. Craswell and Taylor (1991)

classify audit firms as specialists if they earn ten per cent or greater market share

based on the number of clients, audit fees or total fees in industries which contain

more than thirty companies. The rationale for using market share is that the demand

for industry specialists drives audit firms’ investments in specialization, and leads to

industry-based clienteles.

Craswell et al., (1995) refined this proxy. They use a threshold of ten per cent market 6

share based on either the number of clients or percentage of total fees. It has been

argued that a 10% share of the market is currently insufficient to identify

specialization when the number of large providers has decreased. The increased

concentration after the audit firm mergers means that the 10% benchmark is more

easily attainable by the large firms. Ritson et al., (1997) and Ferguson and Stokes

8
(2002) argue that the uniqueness of specialization requires a higher benchmark, and

both use a 20% cut-off. Rather than using a cut-off of market share, DeFond et al.,

(2000) classify audit specialists as the three largest providers in each industry

category. Ferguson et al., (2003) identify industry leaders using audit fee market

share.

Perceptions of the client also play a role in determining which accounting firms are

the industry specialists (Hogan and Jeter, 1999; Ferguson and Stokes, 2002). From a

client’s point of view, there may be an incentive to switch to firms that audit their

industry’s largest companies in order to take advantage of the audit firm’s knowledge

of the best technologies or strategies.

Clients may also identify industry specialists by looking at the specializations

promoted by audit firms. Audit firms can communicate this information to potential

clients by a number of mechanisms, including their websites (Hogan and Jeter, 1999).

An examination of the websites of the Big 5 accounting firms in Australia around the

time of the merger revealed that they did not always clearly indicate their areas of

specialization. Often the firms stipulated that they possess industry expertise without

providing evidence to support their claim. In addition, disparate definitions of

specialists were used, ranging from the firm’s industry revenue, number of staff, and

number of well-known clients. Further, firms adopt different measures for different

industries and did not disclose any information for others. Different categorisations of

industry groups add to the difficulty in comparing across audit firms. For these

reasons, specializations promoted through the firms' websites are not used as a

measure of industry specialization in this study.

9
In this study PwC is defined as a specialist if it attained a critical mass in an industry.

As critical mass can be variously defined, this study employs three measures of

industry specialization. The three measures are based on a twenty per cent (later

relaxed to 15%) market share of (1) the number of clients, (2) consolidated audit fees

and (3) consolidated audit and other service fees (total fees),7 as used by Craswell et

al., (1995). Total fees are used as well as audit fees alone, because it is argued that

specialization enables audit firms to offer both higher quality audit and non-audit

services (Craswell and Taylor, 1991; Hogan and Jeter, 1999).8 The data was obtained

from Huntley’s datadisc for all two-digit ASX industry codes (these codes are

explained in Appendix 1).

3.3 Measuring Client Concentration

The two measures of concentration that are generally used are the concentration ratio

and the Herfindahl index. The concentration ratio is the percentage of total sector size

accounted for by the largest companies in each industry and takes into account the

proportionate size of their industry. For this study, the proportionate size is calculated

using the square root of total consolidated assets (A) of the client, consistent with

Kwon (1996). The total assets figure was obtained from the financial statements of all

publicly listed companies pre-merger and post-merger using Huntley’s datadisc. The

concentration ratio is calculated as follows:

n
 Ai
1

Cn = ___________
(1)
k
 Ai
1

10
where k is the total number of listed companies in the industry, n is the number of

largest companies considered. Generally, a four-firm concentration ratio (i.e. n=4) is

calculated (Eichenseher and Danos, 1981; Wootton et al., 1994; Kwon, 1996; Iyer and

Iyer, 1996).

A second measure of client concentration is the Herfindahl index. It is defined as the

sum of squares of the share of industry activity possessed by the k most active

companies in the industry. It can be written as follows:

 Ai2
1

HI = ___________

(2)
k
( Ai)2
1

The Herfindahl index considers variances in activity levels across firms. For example,

a four-client concentration ratio of 0.8 means that the four largest companies in the

industry have an 80 per cent market share. The 80 per cent share could be divided

equally among the companies. Alternatively, two companies could have a 70 per cent

share and the 10 per cent share divided among the remaining companies. The

concentration ratio is equal for both cases, but the Herfindahl Index is larger for the

latter (Wootton et al., 1994). The larger the concentration ratios and Herfindahl

indices, the more concentrated the industry, and the greater the likelihood that

competitors, audited by separate firms pre-merger, will switch to another audit firm

(Kwon, 1996).

11
 (4) RESULTS

Huntley’s datadisc contains information on 1,194 companies listed on the ASX in

1997 and 1,236 companies in 1999. Companies excluded due to missing data required

for this study totalled 97 and 139 for 1997 and 1999 respectively. In addition, 12

companies were omitted for 1997 and 14 for 1999 because they were audited by more

than one firm and total fees could not be attributed to the individual audit firms. Thus,

a total of 1085 and 1083 companies were included in the analysis for 1997 and 1999

respectively.

4.1 Test of Hypothesis One

Table 1 contains switches to and away from the Big 5 audit firms between September

1997 and September 1999. Hypothesis one stated that there would be a greater

number of switches associated with the newly merged audit firm (PwC) than there

would be for other audit firms of similar size (other Big 5 firms). A chi-square test

shows that the proportion of switches concerning PwC is not higher, as hypothesized,

but is in fact significantly lower than that of the combined switches of the four other

Big 5 firms (z = 2.40, p<0.05).9 This is a surprising result, given that all of the

theoretical discussion concerning the incentives to switch suggested that, as a result of

the merger, certain current and potential clients of PwC would have an increased

incentive to switch. Yet PwC was involved in significantly fewer switches (both to

and from the newly merged firm) in the two years after the merger when compared

with the switching activity of the other Big 5 firms. The breakdown in switching

activity, both to and from PwC, shows that post the merger, PwC has been successful

in retaining existing clients and less successful in attracting new clients. This may

have been due in part to a firm wide policy preventing partner redundancies for two

12
years after the merger (Kemeny, 2001), aimed at providing clients with consistency of

service.

[INSERT TABLE 1 HERE]

4.2 The Direction of the Switches

A comparison of PW and CL client listings with that of PwC showed that eight

companies switched to PwC and six companies switched away from PwC for the

period September 1997 to September 1999. These companies are listed in Table 2.

The companies switching to PwC are examined to determine whether they are in the

industries in which PwC became a specialist or enhanced their specialization. The

companies switching away from PwC are examined to determine whether they are in

more highly concentrated industries.

[INSERT TABLE 2 HERE]

4.3 Examination of switches to the merged firm (Hypothesis 2)

Tables 3(a), (b) and (c) contain data regarding the Big 5 audit firms both pre and post

merger by industry category. Table 3(a) lists the number of clients per audit firm (pre-

merger and as at July 1999), Table 3(b) lists the total fees (audit and other services

fees) per audit firm for audits undertaken both sides of the merger, and Table 3(c) lists

the audit fees per audit firm.

[INSERT TABLES 3(a), 3(b) and 3(c) HERE]

13
The tables reveal that PwC emerged as the new market leader in Australia, with 211

public company audits in terms of the number of clients, while retaining second

ranking in terms of both total fees and audit fees. Prior to the merger, KPMG had a

larger number of clients and twice the market share of any other Big 6 audit firm in

terms of total fees. The merger narrowed the gap between KPMG and PwC

particularly in terms of audit fees, potentially resulting in a more equal distribution of

market share by reducing the previous domination of a single audit firm.

Although there was less switching associated with PwC in general, it may still be that

the switches to the merged firm were in the industries in which PwC became an

industry specialist or enhanced their specialization. A test of proportions is performed

in order to determine whether there were more auditor switches in industry categories

where PwC was a specialist compared with those industry categories where PwC was

not a specialist. The results for the different measures of industry specialization are

discussed below.

The data in Table 2 show that eight companies switched to PwC in the two years

following the merger announcement. These switches are to be analysed using tests of

proportions by comparing switches in industry categories where PW and/or CL were

already a specialist or where the firm (PwC) became a specialist (using, in the first

place, a market share of 20% to designate specialist), with those switches in all other

industry categories. This test determines whether potential clients are attracted to

industry specialist audit firms when switching auditors.

14
From Table 3(a) (number of clients) it can be seen that PwC either was or became an

industry specialist in 13 industries10 (using a 20% cut-off). From Table 2 it can be

seen that switches to PwC occurred in 4 of those industries.11 A test comparing the

proportion of switches to PwC in industries in which PwC was deemed a specialist

with the proportion of switches to PwC in industries where it was not deemed to be a

specialist resulted in a test statistic of z = 2.53 (p<.01, one-tailed), which is

significant. From Table 3(b) (audit and other services fees) it can be seen that PwC

either was or became an industry specialist in 11 industries.12 From Table 2 it can be

seen that switches to PwC occurred in 4 of those industries.13 A test of proportions

results in a test statistic of z = 1.74 (p<.05, one-tailed). From Table 3(c) (audit fees) it

can be seen that PwC either was or became an industry specialist in 11 industries.14

From Table 2 it can be seen that switches to PwC occurred in 3 of those industries.15

A test of proportions results in a test statistic of z = 1.84 (p<.05, one-tailed).

These three tests are repeated using 15% as the cut-off. The results for number of

clients and total fees are both the same and significant (z = 2.87, p<.01 one-tailed).

The result for audit fees were also significant (z = 1.84, p<.05). It appears that

potential clients are attracted to industry specialist audit firms.

4.4 Examination of switches away from the merged firm (Hypothesis 3)

Kwon’s (1996) theory suggests that switches away from PwC (identified in Table 2)

are more likely to occur in more highly concentrated industries. An independent

samples t-test is used to compare the mean four-client concentration ratio for the five

industries in which the switches away occurred, to the mean for the seventeen

industries in which switches away did not occur. The results show that the means are

15
not significantly different (t= -0.359, 22df, p=0.723). Similarly, the results are not

significant when the Herfindahl index was used (t= 0.556, 22df, p=0.584). Thus, there

is no support found for Kwon’s (1996) theory.

Kwon’s (1996) argument that switches were more likely to occur for clients in

concentrated industries where a close competitor is audited by the same audit firm,

was not found to hold. However, the results must be interpreted with caution because

the small number of switches and industry categories causes concerns about small

sample sizes. Thus the data was re-examined to see if there was any instance

supporting Kwon's theory.

As such, we examined the largest 500 companies in Australia to identify any large

close competitors audited by PW or CL prior to the merger. This examination

revealed 119 PW and CL clients listed on the ASX in 1997 that could be potentially

large close competitors. It was believed that this concern would be greater if the same

office of the newly merged audit firm undertook the audit of the close competitor.

Competitors that were audited by offices of PW or CL in the same location totalled

45. Of these clients, 28 were found to be in industries with a low client concentration,

with a Herfindahl index of less than 0.1. This process therefore identified 17

companies that, according to Kwon (1996), were most likely to switch away from

PwC as a result of the merger. These 17 companies were in concentrated industries,

and prior to the merger were audited by different audit firms and after the merger

were audited by the same office of the same audit firm. It was found that only one of

these clients switched to another audit firm.16 Personnel at this client were contacted

and it was found that the PwC merger was not an issue in their decision to switch

16
audit firms. Thus, there is no evidence that close competitors, who before the merger

were audited by different auditing firms but as a result of the merger were going to be

audited by the same office of PwC, were switching to another audit firm.17

4.5 Additional Analysis: Audit Fees and High Retention Rates

PwC had a rate of client retention around the merger significantly better than that of

the other Big 5 audit firms.18 One process that could be examined using the data

available was to see whether PwC’s good retention rate might have been due to the

audit fees negotiated around the time of the merger. If PwC charged competitive rates,

or offered some sort of reduced fee, their clients may have been disinclined to switch

away from them. This was examined by calculating the percentage increase in audit

fees associated with the audits undertaken immediately both sides of the merger. The

audit fees for the clients of the Big 5 audit firms were extracted from the Connect 4

database.19 The results in Table 4 indicate that PwC increased audit fees more than

any other Big 5 firm. Thus, audit fee movements do not appear to be a reason for

PwC’s high client retention rate. In fact the results show that in considering the

effectiveness of any of these strategies, you need to consider the strategies of the audit

firm's competitors. The results show that Deloitte Touche Tohmatsu achieved a

significant switch of new clients to their audit firm in the two years after the merger

(Table 1), and this was associated with the most significant decrease in audit fees by

any of the Big 5 firms around the time of the merger (Table 4).

[INSERT TABLE 4 HERE]

17
 (5) SUMMARY AND CONCLUSIONS

The principal objective of this paper is to examine the impact of the PW and CL

merger on auditor-client alignment. The PwC merger was mooted as creating or

enhancing areas of industry specialization that may attract new clients to the merged

firm. This provides the opportunity to examine whether enhanced or newly developed

industry specializations attract any new audit clients. The merger may also create

specific conflicts, with competitors in concentrated industries now being audited by

the same firm, giving some clients an incentive to leave the newly merged audit firm.

This provides an opportunity to test Kwon’s (1996) theory, which suggests that

companies in highly concentrated industries might switch to another audit firm to

avoid being audited by the same audit firm as that which audits their close

competitor(s). This paper contributes to our understanding of auditor-client alignment

by providing evidence as to the influence of industry specialization and client

concentration on auditor choice.

The results do not accord with the expectations that there would be a greater amount

of auditor-client realignment associated with the newly merged audit firm than that of

comparable audit firms. It was in fact found that there was a lower level of client

switching associated with PwC around the time of the merger when compared with

other Big 5 firms. Thus, while PwC were more successful at retaining their existing

clients compared with the other Big 5 firms, they were also less successful at

attracting new clients.

18
In examining the nature of the small number of switches that did occur concerning

PwC, there is support for the view that switches to the newly merged audit firm are

more likely to occur in industries in which it becomes or enhances its industry

specializations. The proxies we use to identify industry specialists provide support

that these switches are more likely to occur in industries of new or enhanced

specialization. In examining the switches away from the newly merged audit firm, the

results do not support Kwon’s (1996) theory, which predicts that competitors in

concentrated industries audited by the newly merged firm are more likely to switch to

another audit firm. The results are not significant using both the four-client

concentration ratio and the Herfindahl index as proxies for the extent of client

concentration. A potential explanation for these results is that different offices of PwC

may audit competitors. However, the rate of switching for competitors audited by the

same office as a result of the merger is no different to the rate of switches away from

the other Big 5 audit firms. In fact, this study could not identify one instance where a

client had left PwC because the newly merged firm was now also auditing its direct

competitor.

The limitations in this study include the fact that the proxies for industry

specialization use arbitrary cut-offs and the results are contingent upon the definitions

employed. However, the study has considered a number of proxies and undertaken

sensitivity analysis in order to overcome this limitation. Another concern is that it is

difficult to identify the exact date on which an auditor-client realignment decision was

made. Sensitivity analysis around this date is undertaken and does not alter the results.

19
The maintenance of their existing client base suggested that PwC was able to put

procedures or incentives in place to limit clients switching away. The results do

suggest that the benefits of enhanced or newly created industry specializations are not

necessarily effective at attracting new clients, but appear to help in retaining existing

clients. Leading personnel at PwC in Australia were contacted and they indicated that

around the merger the firm did put into place mechanisms to manage potential

movements of their existing client database as a result of the merger. These

mechanisms include additional time spent by “relationship personnel” with major

clients to manage any client concerns associated with the merger. Also, as discussed

by Kemeny (2001), there was a firm wide policy preventing partner redundancies for

two years after the merger, aimed at providing clients with consistency of service.

This research indicates that these mechanisms were successful in retaining existing

clients. The paper also considers whether the reduced switching behaviour is

associated with the negotiated level of fees for audit services. However, the results

indicate that this mechanism was not systematically used to prevent clients switching

to other audit firms.

20
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Carcello, J.V., R.H. Hermanson and N.T. McGrath (1992). Audit Quality Attributes:

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Craswell, A.T., J.R. Francis and S.L. Taylor (1995). Auditor Brand Name Reputations

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Craswell, A.T. and S.L. Taylor (1991). The Market Structure of Auditing in Australia:

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Ferguson A., J.R. Francis and D.J. Stokes (2003). The Effects of Firm-Wide and

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Iyer, V. and G.S. Iyer, (1996). Effect of Big 8 Mergers on Audit Fees: Evidence from

the United Kingdom. Auditing: A Journal of Practice and Theory, 15, 123-132.

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Auditor Selection Decision. Auditing: A Journal of Practice and Theory, 15, 53-70.

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24
Appendix 1: Codes for 24 Industry Groups

Code Industry
1 Gold
2 Other Metals
3 Diversified resources
4 Energy
5 Infrastructure and Utilities
6 Developers and Contractors
7 Building Materials
8 Alcohol and Tobacco
9 Food and Household
10 Chemicals
11 Engineering
12 Paper and Packaging
13 Retail
14 Transport
15 Media
16 Banking and Finance
17 Insurance
18 Telecommunications
19 Investment and Financial
Services
20 Property Trust
21 Healthcare and Biotechnology
22 Miscellaneous Industrials
23 Diversified Industrials
24 Tourism and Leisure

25
 Table 1*
Switches to and away from Big 5 audit firms for two years after the PwC merger.

Audit firm Switches to the audit firm Switches away from the audit firm Overall Switches

Proportion Percentage Proportion Percentage Percentage

Arthur Andersen 1 1.19% 8 9.52% 10.71%

84 84
Deloitte Touche Tohmatsu 14 11.20% 6 4.80% 16.00%
125 125
Ernst and Young 10 5.43% 12 6.52% 11.95%
184 184
KPMG Peat Marwick 8 4.04% 5 2.53% 6.57%
198 198
PricewaterhouseCoopers 8 3.19% 6 2.39% 5.58%
251 251

*
The data included in this table includes all data available for companies audited by the Big 5(6). This data varies from that used in tables 3(a)-(c) as some data were not
available for some companies precluding their inclusion in tables (a)-(c).

26
 Table 2

Switches to and from PwC

Switches to PwC Industry Date Switches away from PwC Industry Date

PCG Pch Group Ltd 07 7/11/97 DGD Delta Gold 01 31/10/97

IEQ International Equities 19 14/11/97 EBR Eagle Bay Resources 01 28/11/97

Corporation

NRT Novogen Ltd 21 26/11/97 GCC Greenfields Energy 04 1998

Corporation

SIS Sirius Technologies Ltd 18 1998 GMF Goodman Fielder Ltd 09 1998

HSL Harris Scarfe Ltd 13 1998 BAE Barron Entertainment Ltd 15 1999

LLR Lachlan Resources 02 1999 BOA J Boag and Son 08 1999

SPC S.P.C. Ltd 09 1999

FRT Farnell and Thomas 11 1999

Ltd

24
 Table 3(a)
Number of clients for each of the Big Five (Big Six) by industry category pre and post merger
Industry AA-97 DEL-97 EY-97 KPMG-97 CL-97 PW-97 AA-99 DEL-99 EY-99 KPMG-99 PwC-99
1 14 (5.9%) 22 (9.2%) 36 (15.1%) 24 (10.1%) 29 (12.2%) 9 (3.8%) 11 (4.9%) 24 (10.7%) 27 (12.1%) 24 (10.7%) 37 (16.5%)
2 6 (6.5%) 2 (2.2%) 10 (10.9%) 23 (25.0%) 11 (12.0%) 8 (8.7%) 8 (8.2%) 3 (3.1%) 13 (13.3%) 25 (25.5%) 17 (17.3%)
3 1 (14.3%) (0.0%) 1 (14.3%) 3 (42.9%) 2 (28.6%) (0.0%) 1 (20.0%) (0.0%) 1 (20.0%) 1 (20.0%) 2 (40.0%)
4 3 (5.4%) 4 (7.1%) 12 (21.4%) 7 (12.5%) 5 (8.9%) 2 (3.6%) 4 (6.2%) 6 (9.2%) 14 (21.5%) 12 (18.5%) 7 (10.8%)
5 2 (18.2%) 1 (9.1%) 3 (27.3%) 1 (9.1%) 2 (18.2%) 2 (18.2%) 2 (15.4%) 1 (7.7%) 4 (30.8%) 2 (15.4%) 4 (30.8%)
6 2 (4.5%) 4 (9.1%) 5 (11.4%) 10 (22.7%) 4 (9.1%) 2 (4.5%) 1 (2.3%) 5 (11.6%) 5 (11.6%) 9 (20.9%) 5 (11.6%)
7 1 (4.3%) 3 (13.0%) 2 (8.7%) 4 (17.4%) 3 (13.0%) 2 (8.7%) 3 (12.0%) 2 (8.0%) 4 (16.0%) 5 (20.0%) 5 (20.0%)
8 (0.0%) 3 (25.0%) 1 (8.3%) 1 (8.3%) 2 (16.7%) 3 (25.0%) (0.0%) 4 (23.5%) 1 (5.9%) 2 (11.8%) 5 (29.4%)
9 2 (6.3%) (0.0%) 5 (15.6%) 5 (15.6%) 4 (12.5%) 4 (12.5%) 2 (6.9%) (0.0%) 4 (13.8%) 4 (13.8%) 6 (20.7%)
10 (0.0%) 1 10.0%) 1 (10.0%) 3 (30.0%) 1 (10.0%) 3 (30.0%) (0.0%) (0.0%) (0.0%) 3 (50.0%) 1 (16.7%)
11 3 (8.8%) 2 (5.9%) 4 (11.8%) 6 (17.6%) 6 (17.6%) (0.0%) 2 (6.5%) 2 (6.5%) 3 (9.7%) 4 (12.9%) 7 (22.6%)
12 (0.0%) 1 (16.7%) (0.0%) 1 (16.7%) 2 (33.3%) (0.0%) (0.0%) 1 (14.3%) (0.0%) 1 (14.3%) 2 (28.6%)
13 6 (20.7%) 4 (13.8%) 3 (10.3%) 1 (3.4%) 2 (6.9%) 4 (58.6%) 4 (11.8%) 2 (5.9%) 6 (17.6%) 3 (8.8%) 9 (26.5%)
14 1 (9.1%) 1 (9.1%) 1 (9.1%) 5 (45.5%) 1 (9.1%) (0.0%) 1 (9.1%) 1 (9.1%) (0.0%) 4 (36.4%) 3 (27.3%)
15 4 (12.9%) 1 (3.2%) 4 (12.9%) 3 (9.7%) 4 (12.9%) 4 (12.9%) 4 (12.9%) 1 (3.2%) 4 (12.9%) 2 (6.5%) 6 (19.4%)
16 1 (5.9%) (0.0%) 2 (11.8%) 6 (35.3%) 1 (5.9%) 1 (5.9%) 1 (7.1%) (0.0%) 2 (14.3%) 6 (42.9%) 2 (14.3%)
17 3 (27.3%) 1 (9.1%) 1 (9.1%) 2 (18.2%) 2 (18.2%) 2 (18.2%) (0.0%) 1 (14.3%) 1 (14.3%) 3 (42.9%) 2 (28.6%)
18 (0.0%) 3 (18.8%) 5 (31.3%) 4 (25.0%) (0.0%) 1 (6.3%) 1 (4.3%) 6 (26.1%) 4 (17.4%) 1 (4.3%) 5 (21.7%)
19 6 (4.8%) 15 (11.9%) 8 (6.3%) 13 (10.3%) 8 (6.3%) 13 (10.3%) 6 (5.6%) 12 (11.2%) 6 (5.6%) 12 (11.2%) 21 (19.6%)
20 3 (6.7%) 1 (2.2%) 12 (26.7%) 9 (20.0%) 10 (22.2%) 4 (8.9%) 1 (1.9%) 3 (5.6%) 17 (31.5%) 12 (22.2%) 19 (35.2%)
21 5 (5.2%) 12 (12.4%) 19 (19.6%) 11 (11.3%) 11 (11.3%) 6 (6.2%) 4 (10.8%) 3 (8.1%) 5 (13.5%) 6 (16.2%) 9 (24.3%)
221 8 (8.9%) 9 (10.0%) 10 (11.1%) 15 (16.7%) 8 (8.9%) 9 (10.0%) 10 (6.7%) 18 (12.1%) 25 (16.8%) 22 (14.8%) 25 (16.8%)
23 2 (13.3%) 1 (6.7%) 2 (13.3%) 6 (40.0%) 1 (6.7%) 2 (13.3%) 2 (9.5%) 5 (23.8%) 2 (9.5%) 4 (19.0%) 5 (23.8%)
24 5 (16.7%) 5 (16.7%) 4 (13.3%) 6 (20.0%) 3 (10.0%) 2 (6.7%) 5 (16.1%) 4 (12.9%) 6 (19.4%) 3 (9.7%) 7 (22.6%)
TOTAL 78 (7.2%) 96 (8.9%) 151 (13.9%) 169 (15.6%) 122 (11.3%) 83 (7.7%) 73 (6.7%) 104 (9.6%) 154 (14.2%) 170 (15.7%) 211 (19.5%)
AA= Arthur Andersen, DEL=Deloitte Touche Tohmatsu, EY=Ernst and Young, KPMG=KPMG, CL=Coopers and Lybrand, PW=Price Waterhouse, PwC=PricewaterhouseCoopers, 97 = 1997,
98 = 1998

1 During 1998 a number of companies were reclassified by the ASX as miscellaneous, from various other industries. This reclassification did not significantly change our results.

25
 Table 3(b)
Audit and other services fees for each of the Big Five (Big Six) by industry category pre and post merger
Industry AA-97 DEL-97 EY-97 KPMG-97 CL-97 PW-97 AA-98 DEL-98 EY-98 KPMG-98 PwC-98
1 2,552 (16.8%) 1,895 (12.5%) 2,622 (17.3%) 1,227 (8.1%) 3,252 (21.4%) 1,039 (6.8%) 1,752 (11.0%) 2,152 (13.5%) 2,157 (13.6%) 1,530 (9.6%) 5,394 (33.9%)

2 108 (0.9%) 19 (0.2%) 1,194 (9.5%) 1,349 (10.7%) 7,443 (59.0%) 1,295 (10.3%) 241 (1.6%) 39 (0.3%) 1,718 (11.2%) 1,981 (12.9%) 10,625 (69.4%)
3 10,900 (50.5%) (0.0%) 87 (0.4%) 3,058 (14.2%) 7,526 (34.9%) (0.0%) 13,000 (56.7%) (0.0%) 67 (0.3%) 2,719 (11.9%) 7,153 (31.2%)

4 105 (1.2%) 403 (4.6%) 2,383 (27.4%) 2,447 (28.1%) 1,371 (15.8%) 164 (1.9%) 348 (4.3%) 353 (4.3%) 1,970 (24.1%) 2,839 (34.8%) 1,430 (17.5%)

5 794 (40.6%) 400 (20.5%) 148 (7.6%) 40 (2.0%) 427 (21.9%) 145 (7.4%) 2,603 (52.0%) 800 (16.0%) 427 (8.5%) 161 (3.2%) 1,010 (20.2%)

6 179 (1.6%) 663 (5.8%) 1,041 (9.1%) 6,619 (57.6%) 1,120 (9.8%) 554 (4.8%) 266 (2.1%) 763 (6.2%) 1,334 (10.8%) 7,177 (58.0%) 1,505 (12.2%)

7 2,600 (9.7%) 3,769 (14.1%) 155 (0.6%) 13,528 (50.6%) 5,032 (18.8%) 151 (0.6%) 3,757 (12.9%) 2,953 (12.9%) 382 (1.7%) 9,709 (42.5%) 4,586 (20.1%)

8 (0.0%) 3,652 (22.6%) 82 (0.5%) 82 (0.5%) 2,180 (13.5%) 9,981 (61.8%) (0.0%) 3,379 (25.6%) 90 (0.7%) 99 (0.7%) 9,267 (70.1%)

9 7,826 (29.4%) (0.0%) 3,407 (12.8%) 6,033 (22.7%) 5,412 (20.4%) 1,637 (6.2%) 8,254 (26.6%) (0.0%) 10,575 (34.1%) 5,679 (18.3%) 4,867 (15.7%)
10 (0.0%) 13 (0.4%) 60 (1.7%) 1,712 (47.8%) 349 (9.7%) 1,254 (35.0%) (0.0%) (0.0%) (0.0%) 3,501 (89.3%) 187 (4.8%)

11 715 (7.5%) 194 (2.0%) 3,687 (38.6%) 1,883 (19.7%) 1,518 (15.9%) (0.0%) 496 (7.6%) 347 (5.3%) 838 (12.9%) 1,739 (26.8%) 1,544 (23.8%)

12 (0.0%) 42 (0.6%) (0.0%) 6,600 (89.3%) 603 (8.2%) (0.0%) (0.0%) 78 (1.1%) (0.0%) 6,100 (82.4%) 1,030 (13.9%)

13 2,144 (16.0%) 478 (3.6%) 2,354 (17.6%) 938 (7.0%) 186 (1.4%) 4,881 (36.5%) 805 (4.7%) 151 (0.9%) 4,845 (28.3%) 941 (5.5%) 8,187 (47.9%)

14 88 (0.5%) 4,600 (24.4%) 13 (0.1%) 13,782 (73.0%) 63 (0.3%) (0.0%) 113 (1.0%) 6,300 (55.2%) (0.0%) 4,423 (38.7%) 167 (1.5%)

15 11,729 (66.9%) 409 (2.3%) 1,498 (8.5%) 1,570 (9.0%) 178 (1.0%) 1,087 (6.2%) 13,792 (56.0%) 368 (1.5%) 4,971 (20.2%) 2,069 (8.4%) 2,241 (9.1%)

16 78 (0.1%) (0.0%) 7,304 (11.4%) 42,933 (67.0%) 5,900 (9.2%) 1,692 (2.6%) 116 (0.2%) (0.0%) 7,277 (11.2%) 46,500 (71.8%) 10,662 (16.5%)

17 3,556 (21.1%) 4,274 (25.4%) 189 (1.1%) 1,207 (7.2%) 5,171 (30.7%) 2,457 (14.6%) (0.0%) 4,996 (13.6%) 209 (0.6%) 25,547 (69.6%) 5,931 (16.2%)

18 (0.0%) 309 (5.5%) 1,372 (24.3%) 3,722 (66.2%) (0.0%) 55 (1.0%) 22 (0.2%) 2,257 (17.1%) 6,496 (49.1%) 134 (1.0%) 3,610 (27.3%)
19 337 (3.6%) 1,465 (15.4%) 1,380 (14.5%) 1,985 (20.9%) 187 (2.0%) 446 (4.7%) 452 (3.9%) 1,485 (12.9%) 324 (2.8%) 5,654 (49.0%) 1,076 (9.3%)

20 220 (1.3%) 54 (0.3%) 2,655 (15.9%) 9,766 (58.3%) 2,960 (17.7%) 282 (1.7%) 204 (1.6%) 714 (5.6%) 2,604 (20.4%) 4,210 (33.0%) 4,527 (35.5%)

21 715 (3.7%) 5,986 (30.6%) 2,701 (13.8%) 2,569 (13.1%) 2,845 (14.5%) 1,214 (6.2%) 689 (5.4%) 1,095 (8.5%) 1,264 (9.9%) 6,400 (49.9%) 2,710 (21.1%)
1
22 881 (5.9%) 3,017 (20.2%) 782 (5.2%) 2,774 (18.6%) 2,281 (15.3%) 3,083 (20.7%) 1,291 (5.4%) 6,316 (26.4%) 4,219 (17.6%) 3,157 (13.2%) 5,358 (22.4%)

23 1,346 (4.4%) 243 (0.8%) 2,449 (8.0%) 22,718 (73.9%) 397 (1.3%) 3,288 (10.7%) 1,856 (7.0%) 3,860 (14.6%) 2,623 (9.9%) 13,664 (51.7%) 3,959 (15.0%)

24 1,964 (18.8%) 927 (8.9%) 3,997 (38.2%) 1,864 (17.8%) 906 (8.6%) 549 (5.2%) 2,044 (19.9%) 455 (4.4%) 3,972 (38.7%) 1,138 (11.1%) 2,261 (22.1%)

TOTAL 48,837 (12.2%) 32,812 (8.2%) 41,560 (10.4%) 150,406 (37.6%) 57,307 (14.3%) 35,254 (8.8%) 52,101 (12.1%) 38,861 (9.0%) 58,362 (13.6%) 157,071 (36.5%) 99,287 (23.1%)
AA= Arthur Andersen, DEL=Deloitte Touche Tohmatsu, EY=Ernst and Young, KPMG=KPMG, CL=Coopers and Lybrand, PW=Price Waterhouse, PwC=PricewaterhouseCoopers, 97 = 1997,
98 = 1998
1During 1998 a number of companies were reclassified by the ASX as miscellaneous, from various other industries. This reclassification did not significantly change our results.

26
 Table 3(c)
Audit fees for each of the Big Five (Big Six) by industry category pre and post merger
Ind AA-97 DEL-97 EY-97 KPMG-97 CL-97 PW-97 AA-98 DEL-98 EY-98 KPMG-98 PwC-98

1 715 (9.3%) 1,214 (15.8%) 1,190 (15.5%) 761 (9.9%) 1,674 (21.8%) 462 (6.0%) 647 (8.7%) 1,453 (19.6%) 1,082 (14.6%) 908 (12.3%) 1,642 (22.2%)
2 143 (2.0%) 18 (0.2%) 713 (9.9%) 734 (10.2%) 4,122 (57.2%) 719 (10.0%) 120 (1.8%) 28 (0.4%) 895 (13.6%) 955 (14.5%) 4,095 (62.0%)
3 6,608 (46.0%) (0.0%) (0.0%) 1,455 (10.1%) 6,302 (43.9%) (0.0%) 7,156 (46.4%) (0.0%) 100 (0.6%) 1,185 (7.7%) 6,969 (45.2%)
4 56 (1.4%) 302 (7.7%) 670 (17.0%) 962 (24.4%) 564 (14.2%) 84 (2.1%) 141 (3.4%) 255 (6.1%) 657 (15.8%) 1,411 (33.9%) 533 (12.8%)
5 126 (13.6%) 345 (37.1%) 126 (13.6%) 16 (1.7%) 283 (30.5%) 33 (3.6%) 340 (20.8%) 465 (28.4%) 620 (37.9%) 37 (2.3%) 173 (10.6%)
6 140 (2.3%) 451 (7.3%) 374 (6.1%) 3,220 (52.4%) 421 (6.8%) 358 (5.8%) 141 (2.5%) 532 (9.4%) 685 (12.1%) 2,466 (43.4%) 820 (14.4%)
7 1,819 (18.6%) 2,594 (26.5%) 83 (0.8%) 2,753 (28.1%) 1,199 (12.2%) 200 (2.0%) 2,695 (26.6%) 2,420 (23.9%) 234 (2.3%) 2,305 (22.8%) 1,311 (12.9%)
8 (0.0%) 994 (21.6%) 53 (1.2%) 40 (0.9%) 969 (21.1%) 2,449 (53.3%) (0.0%) 994 (20.3%) 66 (1.3%) 70 (1.4%) 3,572 (73.0%)
9 2,120 (17.9%) (0.0%) 3,074 (25.9%) 3,357 (28.3%) 1,538 (13.0%) 791 (6.7%) 2,115 (19.3%) (0.0%) 3,300 (30.1%) 2,707 (24.7%) 1,812 (16.5%)
10 (0.0%) 12 (0.5%) 45 (1.8%) 1,419 (58.9%) 172 (7.0%) 656 (26.8%) (0.0%) (0.0%) (0.0%) 2,537 (89.1%) 135 (4.7%)
11 339 (5.5%) 129 (2.1%) 2,801 (45.4%) 1,005 (16.3%) 809 (13.1%) (0.0%) 164 (4.0%) 194 (4.7%) 857 (20.8%) 749 (18.2%) 960 (23.3%)
12 (0.0%) 38 (0.7%) (0.0%) 4,927 (87.0%) 575 (10.2%) (0.0%) (0.0%) 60 (1.1%) (0.0%) 4,755 (84.8%) 618 (11.0%)
13 1,490 (18.4%) 259 (3.2%) 1,257 (15.5%) 254 (3.1%) 27 (0.3%) 3,574 (44.1%) 685 (8.6%) 78 (1.0%) 2,235 (28.1%) 268 (3.4%) 3,395 (42.7%)
14 56 (0.7%) 3,500 (44.0%) 13 (0.2%) 4,137 (52.0%) 33 (0.4%) (0.0%) 56 (0.9%) 4,346 (66.8%) (0.0%) 1,760 (27.1%) 116 (1.8%)
15 6,672 (61.9%) 180 (1.7%) 1,346 (12.5%) 953 (8.8%) 129 (1.2%) 904 (8.4%) 7,933 (63.5%) 265 (2.1%) 1,517 (12.1%) 940 (7.5%) 1,248 (10.0%)
16 16 (0.1%) (0.0%) 2,875 (13.5%) 12,665 (59.5%) 3,190 (15.0%) 784 (3.7%) 55 (0.3%) (0.0%) 3,028 (16.0%) 10,111 (53.6%) 4,171 (22.1%)
17 2,023 (19.1%) 3,753 (35.5%) 168 (1.6%) 635 (6.0%) 2,374 (22.4%) 1,628 (15.4%) (0.0%) 3,025 (17.7%) 6,677 (39.1%) 3,696 (21.7%) 3,490 (20.5%)
18 (0.0%) 108 (3.9%) 664 (23.8%) 1,904 (68.1%) (0.0%) 46 (1.6%) 19 (0.2%) 492 (6.4%) 5,436 (70.2%) 90 (1.2%) 1,325 (17.1%)
19 291 (5.4%) 916 (17.1%) 631 (11.8%) 789 (14.7%) 141 (2.6%) 265 (4.9%) 260 (4.1%) 958 (15.3%) 187 (3.0%) 2,316 (36.9%) 674 (10.7%)
20 181 (4.9%) 54 (1.5%) 1,257 (33.8%) 514 (13.8%) 965 (26.0%) 175 (4.7%) 127 (2.5%) 475 (9.3%) 1,913 (37.4%) 443 (8.7%) 1,306 (25.5%)
21 354 (4.0%) 2,695 (30.6%) 1,581 (17.9%) 900 (10.2%) 718 (8.1%) 507 (5.8%) 400 (7.1%) 950 (16.7%) 485 (8.5%) 2,686 (47.3%) 853 (15.0%)
221 881 (5.9%) 3,017 (20.2%) 782 (5.2%) 2,774 (18.6%) 2,281 (15.3%) 3,083 (20.7%) 1,291 (5.4%) 6,316 (26.4%) 4,219 (17.6%) 3,157 (13.2%) 5,358 (22.4%)
23 1,346 (4.4%) 243 (0.8%) 2,449 (8.0%) 22,718 (73.9%) 397 (1.3%) 3,288 (10.7%) 1,856 (7.0%) 3,860 (14.6%) 2,623 (9.9%) 13,664 (51.7%) 3,959 (15.0%)
24 1,964 (18.8%) 927 (8.9%) 3,997 (38.2%) 1,864 (17.8%) 906 (8.6%) 549 (5.2%) 2,044 (19.9%) 455 (4.4%) 3,972 (38.7%) 1,138 (11.1%) 2,261 (22.1%)
TOT. 27,340 (12.6%) 21,749 (10.1%) 26,149 (12.1%) 70,756 (32.7%) 29,789 (13.8%) 20,555 (9.5%) 28,245 (12.4%) 27,621 (12.1%) 40,788 (17.9%) 60,354 (26.5%) 50,796 (22.3%)

AA= Arthur Andersen, DEL=Deloitte Touche Tohmatsu, EY=Ernst and Young, KPMG=KPMG, CL=Coopers and Lybrand, PW=Price Waterhouse, PwC=PricewaterhouseCoopers, 97 = 1997, 98 = 1998
1: During 1998 a number of companies were reclassified by the ASX as miscellaneous, from various other industries. This reclassification did not significantly change our results.

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 Table 4

Increase in audit fees from 1997 to 1998

Audit firm Percentage increase

in audit fees
Arthur Andersen 3.64 %

Deloitte Touche Tohmatsu -5.64 %

Ernst and Young -2.06 %

KPMG Peat Marwick 4.15 %

PricewaterhouseCoopers 5.83 %

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 ENDNOTES

1
The merger had a significant effect in Australia, creating a very large accounting firm with total fees
of more than $700 million and over 5,200 partners and staff (PwC website). As a result, the audit
section of PwC was anticipated to emerge with a dominant market share in many industries. For a
discussion of the effect of the merger on auditor concentration in Australia, please refer to Thavapalan
et al., (2002).
2
Sullivan (2002) found that there was a cost benefit enjoyed by large companies that switched to the
newly merged audit firms when the Big 8 became the Big 6 in the late 1980s.
3
Clients switching away from PwC in response to fears of confidential information being transferred to
competitors would be expected to act almost immediately. It is possible that clients switching to PwC
in order to reap the benefits of increased specialization may take a longer time to switch to the newly
formed entity.
4
Other reasons for discrepancies between the two lists include newly listed clients, delisted clients and
those that changed names. These were identified using Huntley’s datadisc.
5
The Huntley’s datadisc was found to have a lag in their monthly update in the auditor field. All 1997
switches were reviewed to eliminate those that occurred before September 18, 1997. The first official
notice of intention to switch was taken as the event date. This was usually identified by a notice of
intention to remove the auditor, or the date of the meeting of shareholders for ratification of the switch.
Notice of intention to remove the auditor must be 2 months before the meeting ratifying the switch, in
accordance with The Corporations Law, section 329(1A). A sensitivity analysis of switches occurring
after January 1, 1998 was undertaken. This did not significantly affect the results reported later in the
paper.
6
They also undertook a sensitivity analysis using a 20% market share.
7
Huntley’s datadisc includes fees attributable to other auditors of the consolidated group. However, the
occurrence of fees paid to other auditors is infrequent and is not expected to impact upon the results.
Craswell et al (1995) found that there were no significant differences between total audit fees reported
by the consolidated group of companies and audit fees attributable to the auditor of the parent
company.
8
Craswell and Taylor (1991) argued that specialist audit firms have superior knowledge of the industry
and are more likely to provide value-enhancing non-audit services. Thus specialization in audit services
facilitates specialization in non-audit services (Hogan and Jeter, 1999).
9
Because of potential problems with identifying the exact timing of the decision to switch auditors, a
sensitivity analysis of switches with a date after 1 January 1998 was conducted. It was also found that
the switching rate of PwC clients using this revised date was lower than the combined switching rate of
the other Big 5 (z=2.30, p<0.05).
10
Industries 2, 3, 5, 7, 8, 9, 10, 12, 13, 15, 17, 20 and 23
11
Industries 2, 7, 9 and 13
12
Industries 1, 2, 3, 5, 8, 9, 10, 13, 17, 21 and 22
13
Industries 2, 9, 13 and 21
14
Industries 1, 2, 3, 5, 8, 9, 10, 13, 17, 20 and 22
15
Industries 2, 9 and 13
16
This firm was Goodman Fielder Ltd. They were audited by PW’s Sydney office while their
immediate identified competitor, Arnotts Ltd, was audited by the Sydney office of CL.
17
This conclusion did not change if the analysis was undertaken on the 45 major clients audited by the
same office, or the 119 top 500 clients.
18
PwC also experienced a rate of switching significantly below the Australian historical rate of
approximately 6% a year.
19
This database contains details of the top 500 companies in Australia. Two hundred and eighty seven
of these were clients of the Big 5, who did not switch auditors in 1997 and 1998.

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